Greetings to you all, welcome to the presentation of Sandvik's results for the second quarter in 2016. With me here on stage today I have, as usual, Björn Rosengren, our CEO, and Tomas Eliasson, our CFO. They will run through the presentation, after which we'll open up for a question and answer session. Without further ado, I ask you to please go ahead with the presentation.
Thank you, Ann-Sofie. Welcome to this quarter two report. With me here today, I have Tomas, who will help me to do some number crunching as well as answer some of your questions. I think the first quarter was pretty much in line with our expectations and the targets to make Sandvik a more profitable company. The markets continue to be challenging. Also this quarter, we saw the currency going against us. Despite that, I think we managed to deliver 13.4%, which we are very pleased with. The organic growth was minus 4%, both for orders as well as invoicing. We start comparing ourselves with a little bit easier quarter going forward. I think the first half year of 2015 was the most challenging period.
Also, during this quarter, we had the Capital Markets Day where we presented the strategy going forward and some of the changes that we are doing. To summarize that, we are consolidating the five business areas into three business areas. We have identified what we call non-strategic operations. We are towards a more decentralized structure and decision making in the company, we also launched the new group targets. We'll come back to all of these a little bit forward. We have also earlier today announced that we have signed an agreement with a company called CoBe Capital, a private equity company, where we'll be divesting the Mining Systems to. We'll come back to that a little bit later. I mentioned that we are moving into a so-called decentralized operations.
That means actually moving the decision making down in operation closer to our customers to make sure that we can respond to our customers' demands much quicker. This is nothing new in Sandvik. I think previous, if you go back in time, Sandvik is coming from a decentralized operation, this has been well received in all our units out there. The difference from previous is that we are actually moving the responsibility even further down from the businesses to what we call product areas, PAs. Under there, we also have a number of business units. Today we have 17 product areas with full balance sheet and profit loss responsibility. We also set up the financial targets, we are going actually from a business cycle into a three-year target.
The reason for this is that we feel a little bit unsure how good the markets will be during the coming years. For us, it's important to focus on profit improvements in our operations, even though the markets are not too generous. Our objective is to, during the next three years, deliver 7% improved EBIT margin per year. We are moving towards our objective to make Sandvik a 15% EBIT margin company. At the same time, we of course also want to improve our return on capital employed, and during the three-year period, the objective is to improve it with three percentages. You all know that we have a strained balance sheet, and our ambition is to get our gearing down. We will continue to do that. We have a dividend policy, which is generous, and we are planning to continue with that.
If we look at the different markets, I have to press many times, but maybe it come here. We can see that there's not so much change in the different markets. Europe continued to be flat on a good level, steady level. I would say probably that East Europe is a little bit stronger than the western part. Also Germany shows strength. North America, I think Asia is an improvement here. You saw we had a negative during the previous quarter, and now it's +5% on Asia. To be mentioned here is that China is still negative with 4%. North America is probably the area where we are seeing that the market is the toughest at the moment, and we don't see any recovery yet at the moment. It's down 10%.
There are, of course, segments in the U.S. or in North America where we see good development, and that is in the aviation and still the automotive industry is very strong. If we're looking at the different segments, what we are pleased to see is that the mining industry is stabilizing. That's good. We see also strong, as I mentioned, automotive and in aviation. Construction is also pretty steady, while we see the biggest challenges in the oil and gas industry, which is nothing new. Just strange. The oil price has stabilized just below $50, but so far, we don't see any big movements in the investment climate. On the general engineering side, it is challenging, especially in North America. As we talked about before, there is a very strong relation about general engineering and the oil and gas industry.
Also, I think we also mentioned before is that we have not seen that the number of drill rigs in North America is declining, rather coming back a little bit. So far, it doesn't really be seen in our numbers, but still a little bit in the right direction. If you're looking at both our orders and our revenues, we can see that the organic growth is -4% for both of them, and the currency effect is about 5%. What you can see on the order received here on the chart is that the last four quarters are pretty flat, so we are not going down. It's actually flattening out here on that side. Moving over to the EBIT development, I mentioned 13.3%, and in that, it's actually down 9% compared to last year. If you look at the currency effect, it's about 1.1%.
If you add that on, we would end up at SEK 14.4. I think by that, we feel that this is very strong numbers. This is very much driven by many of the projects we have, both when it comes to the back end on the Supply Chain Optimization Program, where the project is moving according to plan. There is also a lot of initiatives when it comes to sales and administration costs in all our operating entities, and that will continue going forward. If we look into our five different businesses, starting up with the Sandvik Machining Solutions, I think this is the strongest result of the business unit. I think they presented a good report. We can see organically, they are flat at the moment, and also currency that was against them with 0.7%. Despite that, 21.8% EBIT margin, which I think is very good.
Good is also to see that the net working capital is very stable, and they produce a very strong cash flow for the group. That is moving in a good direction. On the mining side, the margins are here pretty much in line with our expectation. I think the positive side is here that we see an improvement on the equipment side. I think that's positive. Also the aftermarket is steadying out, which is also good. We should know that we are comparing this quarter, which is a flat quarter compared to previous year, with a very strong one last year. It is good numbers in that way. Mining and construction, as you know, are merging at the moment, and there is a lot of focus today to getting the new 5 Product Areas, or sorry, 8 Product Areas up and running.
The management is in place, and I think it's moving very much in a good direction. Also, Sandvik Materials Technology shows stable profit levels, 8.8%. If you take away the metal surcharges, it's 8.5%. They were a little bit positive by SEK 9 million this year. On the organic growth, it was down -8%, -6%. If you actually take out the surcharges out of that, it's pretty flat. It's -2% and -1%. Pretty much. We had a great order from China from the nuclear industry, which we were very happy with. We have, as you know, big expectations from the nuclear industry in China. We had a small cancellation or as a reprioritization from the umbilical side. More focus on some of the bigger orders that we had there. Otherwise, I think this was pretty much what we expected.
On the construction side, I think you probably realize that the numbers were a little bit weaker than the expectations. In the EBIT numbers, we have taken a number of provisions, I think around SEK 40 million at the moment, which is in relation to the merge into the mining business. What we are actually making sure that the construction they are moving into mining is clean at the moment. If you would add that on, we are just under 4%, which is not different from previous quarter. We can also see that organically we are down 13%, but we should know that last year we received a large order from Australia, the tunneling order. If you exclude that, it's about -6%. Net working capital continues to work favorably going forward.
The last one, that's probably the last time we talk about Venture, that is also pretty much in line with your expectation. The order intake is -10% year-over-year. Here we know that there are two businesses which is pretty much related to the oil and gas industry, and that is the Varel or drilling and completion, as we call it today. That is now being moved into the mining operations. The other one is Hyperion, the diamond part of that business, which is a little bit under pressure. At the same time, I think they did a good quarter. Also, Processing Systems, which is one of the companies that will be divested, had very good orders at the quarter. The last business, the Wolfram business, will be merged into the SMS business, had also very solid numbers during the quarter.
With that, I let you talk a little bit about the numbers.
Okay. Thanks, Björn. Good afternoon, everybody. Let's immediately go to the financial summary. Top line, as you heard, -4% organically, both on the orders and revenues. Currency effect, -5%, both on orders and revenues. We do have a couple of very small acquisitions, but they're so small, so they're not significant that will really affect the numbers. All in all, -9% on orders and -8% on revenues. Excuse me. The margin, 13.3%, SEK 2.7 billion in earnings, down a bit from previous year, but not too bad considering the currency headwinds and the volume drop that we do have with 4%. Working capital, 28% compared to 29% of the revenues last year. An improvement, although sequentially, it is a bit up, which of course impacts the cash flow, which you see on the next line.
Cash flow is lower than last year. We'll come back to that in a minute. The return on capital employed, 11%. Now, let me say that for those of you who attended the Capital Markets Day, you heard us talk about the new financial targets going from 14%-17% in return on capital employed. What is the 11%? Well, the 11% is as reported. The financial targets excludes all the one-offs, and we're still carrying with us one-off costs from 2015 in this return number, but that will be gone when the year is over. It goes up a couple of percentage units. Okay, let's move to the bridge. The three biggest impacts are, as usual, organic growth, savings programs, and currency.
We have more numbers on the next page, but on this page here, we can talk a little bit about the savings programs, SEK 214 million in the quarter. We have now reached SEK 1.5 billion in installed savings of the SEK 2.1 billion that we will achieve at the end of 2017. There is SEK 600 million to go. There will be a substantial chunk of that in the second half of 2016, and then a couple of hundred million SEK in 2017, and then there will be mathematical spill over to 2018 of around SEK 100 million. Let's look at the numbers in the bridge, including top line as well. In the first column here, you see price, volume, or organic development, including the savings. So 4% on the top line means SEK 637 million down. The EBIT effect is flat, but it is actually a little bit positive, including the savings.
This means that we have a 50 basis points accretion to the EBIT margin from the organic part of the business. Currency, of course, 5%, SEK 1.065 billion on the top line, and the currency effect is SEK 391 million. So that is a dilution of 1.1 percentage units, as Björn said here just a moment ago. So quite substantial. Then structure, one-offs, alloys, surcharges, metal price effect, et cetera. Take that out, you have another 50 basis points. So from 13.4% to 13.3%, and here are the components. Okay, let's talk a bit about working capital. Working capital on the left-hand side here, 28% compared to 29% a year ago, although sequentially, it is up a bit.
If you look at the right-hand side, you can see how the businesses are developing where Mining is improving, Construction is improving, Machining Solutions is flattish, and Materials Technology is up a bit. It is very important to say here that we do not have an inventory issue. Inventories are down all over the place. Accounts receivables are down. Payables goes a little bit in the wrong direction, but the biggest impact here is actually advances from customers. We do not have as much advances this year within Materials Technology as we had last year. That, of course, has an impact. But the summary of that thing is that inventories are going down for all businesses and for the whole company. Right. Cash flow, SEK 2 billion, compared to SEK 2.7 billion a year ago. This is cash flow before financial items, taxes, and acquisitions.
As you can see on the table on the right-hand side, of course, we make less money. We have a decline organically. We basically keep the margin, but as we have a volume decline, of course, in absolute terms, we have less cash. Working capital is up a bit, and CapEx investments are down or improving. So all in all, SEK 2 billion compared to SEK 2.7 billion, 24% down. The net debt continues to go down year-over-year. There is always a pickup in Q2, as you can see in the chart here, and that is because we have a dividend in the second quarter. Gearing is around 1.0, and the target of getting to 0.8% in gearing is firm. Guidance, if you look at the second quarter, we guided SEK 500 million in negative currency impact, transaction and translation. We end up on SEK 391 million.
Metal prices, we said SEK -50, but it stopped at SEK +9. For the third quarter, we guide with the currency rates we have today, or I think it may be yesterday.
End of June.
End of June as well. Oops, three weeks out. We said SEK -100 million, and the metal price effect is expected to be SEK +13 million. The full year, we haven't done any changes on the outlook at all. We say CapEx less than SEK 4.1 billion. The financial items or the finance net, somewhere between SEK 1.7 and SEK 1.9. If we would say something here, it's maybe more closer to SEK 1.7 than SEK 1.9, so it's moving in the right direction. The tax rate somewhere between 26% and 28%. Now, just a few words on Brexit. We get a lot of questions on this one, of course, and I'm sure we will get more questions on it, so let's be a bit preemptive here and give you the basic facts. It's really two issues here.
Do we have an impact on the currency flows from the British pounds, the depreciation? How big is the U.K. in our business? Let's start with the size of the business. 2015 had sales of SEK 3.8 billion. Of course, it's the fourth largest market that we have. If we have a downturn in the U.K. economy, of course it impacts us. SEK 3.8 billion, around 5% of the total company. The net assets invested in the companies that we have is SEK 3.7 million. We have 11 production sites, eight sales units, and around 1,400 employees. The currency flows match, actually. The short and long positions on the British pounds are more or less exactly the same. This means that we don't have an impact short term or an immediate impact on the currency flows, regardless of where the pound goes.
The conclusion is that, as I mentioned, no immediate currency impact, but the U.K. is still an important market for us. You see the numbers, and we don't disclose margins by country, but you can do your own assumptions here. With that, I'll hand over to Björn again for conclusions.
Thank you, Tomas. I will end up with talking a little bit about disruption. As I mentioned, Sandvik is, from my perspective, about 28 operating entities, 17 product areas, and 10 business units, each of them with full responsibility for their P&L and their balance sheets. These all different operations, their performance varies from being extremely successful, stable, and profitable to being less and need more improvements. The important thing is that each of these business units or product areas, they need to have their strategic agenda. That we follow the curve, stability, profitability before growth. That means some of the units, they need to stabilize their business, make sure that there will be no surprises. The next step is to improve the profitability to the right level. When the unit is profitable and stable, then it's time to focus for growth.
This means that all our 27 operating entities needs to focus on continuous improvements. If all our operating units continue to improve, Sandvik will become a more profitable company, and we'll be able to reach our target, to reach the 15% EBIT in the next three years. I think we end there, and then we are open for question and answers.
Yes. Let's go straight to the questions. Are there any questions in the hall here in Stockholm? No, no questions here then. Operator, could you please flip through the first question on the conference call, please?
Thank you. Ladies and gentlemen, if you have a question for the speakers, please press 01 on your telephone keypad. Our first question comes from Guillermo Peigneux-Acuna of UBS. Go ahead, sir. Your line is open.
Thanks, everyone. Good afternoon. I wanted to ask two questions. First, obviously, about the machining solutions and whether you could actually quantify the stocking effect and the additional base effect on the margins, if at all. Maybe a second question on SMT and materials technology. The invoicing continues to be very strong, and while taking away Q1 last quarter, I guess, or intake trails below invoicing. I wonder whether we should see actually an erosion in terms of revenues going into the second half of 2016. Thank you.
Thank you. Let's talk about the stocking effect in SMS. There is a small increase in inventory, which actually is negligible, so it has a very limited effect on the EBIT margin on SMS. The little bit working up in inventory is much related to deliveries that will be seasonal and will be down during the summer period. There is more or less no effect, maybe 0.1% or something like that, but not more. On the SMT part, there we saw that pretty good invoicing, that's correct. We are a little bit optimistic that we should be able to continue to see reasonable development during the second half. We'll be seeing that. There are a lot of exciting areas within SMT. It is related to Iran is one part. The nuclear is very exciting, and we also see some small improvement in some parts in the primary business.
We are carefully optimistic that we should see a reasonable second half of the year when it comes to orders in SMT. At the same time, they are taking the activities that we talked about during the Capital Markets Day to make sure that the costs are related to the revenues. This business is a longer distance between orders and deliveries, which gives us also reasonable time to take action if needed. So far, I think it's moving reasonable growth.
Thank you. Can I just check that the number of extra days doesn't have an impact on margins? I think that should be the case, right?
I think we had two days in the quarter.
That does not impact the margins. It's just basically revenues and orders, that's all.
Correct.
Thank you so much.
Thank you. Operator, can we have the next question, please?
Thank you. Our next question comes from Klas Bergelind. Go ahead, sir, your line is open.
Hi, Björn. Hi, Tomas. It's Klas from Citi. A couple of questions, please. Firstly, starting on mining, demand is up slightly quarter-on-quarter versus flat last quarter. Does this also mean that pricing has improved? I'm thinking about the consumables here, where price pressure has been a key feature over the last 12 months. Atlas is talking about better consumables this quarter. Just want to understand the changing pricing as well.
I would say the challenge hasn't really changed anything from previous quarter. There is correctly on the consumables, some pressure on the pricing side. That is correct. While we see, of course, a little bit more stable in the rest of the aftermarket business, the service and the spare parts, as well as on the equipment.
Okay. My second question is on SMS and general engineering. Last quarter, you were down slightly quarter-on-quarter, and now it looks more stable. It seems like Europe and Asia are the main drivers, North America is still weak. Can you give us some color on China within Asia there? You still say that Asia is down year-over-year, but how did China develop sequentially and by end market, please?
Yeah. If you look at China, the positive in China is automotive that is developing positively as well as the aviation side. Otherwise, it's down about 4% in China. SMS is also down in China, I think with 4% during the quarter. While we see an uptick in the mining side. Otherwise, I would say that no big changes if you're looking sequentially.
Okay. My final question, promise to be brief, is margin in SMS. It's at 22.4% clean of currency and production. This is the highest margin since the peak in 2012. I'm trying to understand this. Is this the extra cost for the product launches that are now leveling off? Or is it that the price mix owing due to more smart tooling, the sensors? What is the key driver?
No, I think it's the projects that are run related to the supply chain optimization program, but also a lot of efforts that have been taken on the S&A cost. They continue to drive this going forward, so it's not an ending. We will continue to make sure that the operations are in line with the demand in the market. I think they're doing this very successfully, and we will continue this.
Thank you, Björn.
Thank you, Klas. Again, do we have any questions here in Stockholm? No. Very quiet. We'll continue with the conference call, please. Operator?
Thank you. Our next question comes from Benjamin Maslen of Morgan Stanley. Please go ahead, sir.
Yeah, thank you. Hi, Björn, Tomas, and Ann-Sofie. Björn, a question on mining, please, and the improvement in demand orders that we've seen sequentially. Has that been driven by any specific product lines or commodities? I know you've given us it geographically, but how does it cut by equipment or the different metal exposures? Thanks.
It's difficult to say if this is coming. The orders are coming in bigger projects and you get orders at a certain time. We look at the metal prices, they have gone up during the last months or quarters, actually. We didn't see from the beginning any reaction in the market. Lately, we've seen good orders in the end of the quarter, which is very positive. There are some positive signals, it's difficult to say. We are not really sure how sustainable this is. I think we should probably wait one more quarter to see how the development before we make any too quick conclusion on the demand in the market. We have seen other times when we've been maybe a little bit optimistic about that. There comes a weak quarter after that.
It is encouraging because we need, of course, orders for the product factories to avoid under absorptions in them. From my perspective, it's encouraging to see that the aftermarket is stabilizing because that is an indication of how the mining operations are working. The more they are working and harder. We have put in a lot of efforts to improve the aftermarket during the last two years, and that should be paying off.
Thank you. A second one, please, on Materials Technology, where I think you normally get a 200 to 300 basis points margin drop sequentially in the summer in Q3. Would you expect the same pattern this year, or would it be lower given that I think the commentary suggests that you were already de-stocking a little bit in the second quarter? Thank you.
This is Sandvik. It becomes weaker during the third quarter. I don't think we should expect any other changes from that. That pattern is not. That, of course, is related to number of working days, and many of our operations, not least the SMS business, SMS and T, it's very much related to that.
Got it. Thank you.
It will be a little bit softer during the quarter. That's pretty clear.
Okay, many thanks.
Thank you. Operator, can we have the next question from the conference call, please?
Thank you. Our next question comes from Magnus Kruber from Kepler Cheuvreux. Go ahead, sir, your line is open.
Hi, Magnus Kruber here. Can I ask, continue with the geographical questions, please, on SMS in particular. We've seen an improvement in growth currently in North America in particular, also in Europe. Can you talk a little bit about if that is just working days, or if there is an improvement in SMS in particular? That's my first question.
Maybe I can answer that. We haven't seen any improvement in North America. Rather opposite. I think it's pretty weak there. If you look at the automotive industry, I think that is more or less flat now. We don't see any growth in that part. We do believe that it's related to a little bit of the de-stocking. Where we've seen improvement is the automotive in China and Europe. That's an improvement. China was still minus and North America is minus, it's Europe which is a strong part of the SMS business.
Is North America, is it accelerating or decelerating, or is it sequentially and throughout the quarter pretty steady? Do you have any feeling at all as to where the stock levels are with your customers?
We would probably say it's a slight down in North America. We do believe that it is related to the de-stocking in the automotive, but it's difficult to say on exactly what level that is. North America is probably the market where we see the biggest challenges. It's not really a Sandvik issue. I think this is really a North American issue.
Okay, thank you. If I can just continue on mining. There's been a couple of project approvals, some big ones like the Oyu Tolgoi expansion, also some others. Can you talk a little bit about your feeling on the talks with the customers, the tendering activity and such? Also, we've heard from some of your competitors that there's an improving situation in gold, which has become quite important for you. Do you agree with that picture or are you seeing something else? Thank you.
No, we agree with that. I think gold is an important for us. The most important is copper. Copper, as you've probably seen, is down actually quarter-over-quarter. Gold is up, we see an increased part on the tendering. It's difficult to see how they will materialize. I think, as I mentioned, we need another quarter to see how that really is. There is a slight optimism in the market.
Okay. Thank you.
Thank you, Magnus. Can we have the next question please for Trey, Operator?
Our next question comes from Peder Frøland of Handelsbanken Capital Markets. Go ahead, your line is open.
Thank you. This is Peder Frøland . Hi, Ann-Sofie, Björn, and Tomas. My first question is on SMT on the umbilical business. You mentioned as a whole that you expect and hope for a stable order situation. Could you just update us how the deliveries will look like for the umbilical? And could you also clarify a bit about that specific umbilical business that I think you put on a cancellation or a postponement? That's my first question. Thank you.
First, when it comes to the umbilical, for the year, as we have mentioned, it looks good. I think you're pretty full during the period, but we are working hard is to improve for 2017 and 2018.
There are a lot of exciting projects. They have to materialize, that's before, but with a slight small optimism that these have a good chance to do that. Related to the cancellation there, that was actually related to one of the big contracts that we took last quarter. The customer had to prioritize on the large project instead of the small one. It was not really taking out that part, that it just put back in time a little bit.
Okay. The magnitude here?
On the cancellations?
Yeah.
Yeah. I think it was totally about SEK 90 million.
My next question, you mentioned the provisions in construction. Now the transformation or the structure of the group is sort of ongoing. Will we see more of this type of provisions when we exit the Mining Systems business, when you get these two divisions together and, obviously, also when you resolve the Sandvik Venture business?
I hope not. Of course, I difficult to say that it will never happen. Things can always happen. I think we feel pretty comfortable at the moment, at least with the merge between construction and mining for this period. It is difficult to say, but I think we feel pretty clean moving into that. On the Sandvik Venture side, the different businesses are moved in, both into Sandvik Machining Solutions. I don't see anything should happen there. Moving into the mining, there should not be anything. That feels pretty clean at the moment. When it comes to Mining Systems that you all know that we announced today the signing of the contract with CoBe Capital, there is a capital loss in that part, which is around SEK 800 million. That is going to be booked as discontinued operations. It will not affect our operating margins.
The deal is, of course, not closed yet. We expect to close this by the end of November. We have a lot of work to be done during this period.
Yeah.
There can be costs in relation to the sales.
Yeah. That's clear.
If you want to add on that a little bit, Tomas.
Yeah. We can elaborate a little bit on that. I mean, the capital loss is estimated to be SEK 800 million. We don't know for sure when the closing is, like in November, hopefully, but around SEK 800 million in capital loss. And then of course, there are transaction costs, et cetera. But the transaction costs and some other costs, they are already provided for last year. That will not impact the P&L going forward. But we don't know. There might be some other costs depending on how it goes, which rolls on a little bit in the future. Not significant, but that might be something. But all of that will be accounted for, as Björn said, in discontinued operations. It will not impact our key numbers or ratios.
In curiosity, were there industrial players that were interested in the Mining Systems business? If so, why are you wanting to divest it to private equity? Is that pure price or loss type of function or?
What we feel important is that there is a future for Mining Systems. We need to make sure that they can continue to operate because they operate with many of our customers we are also using in the mining business, and we need to have a good relation. Most important is that the business continue to have a stable future, and we need to find a player who seems serious and dedicated enough to make sure that this becomes a good business. I think that's important. The reason why this capital cost is so high is because we needed to capitalize the company in a way that it can stand on its own legs in the new structure. That is important. Otherwise, it would be impossible for them to live alone. This is behind that.
There are some restructuring work and there is some capitalization there which is needed to be done, and that's what we put in there. We need to make sure. We do believe that the buyer is the best buyer that we have found so far.
Okay.
Thank you very much.
Great. Thanks a lot.
Thanks.
I believe we have one question here from the room in Stockholm. Please, Anders.
Yes, from Swedbank. Just to follow up on the Mining Systems.
Yeah.
Where is the SEK 600 million cash outlay? Is that the capitalization you talk about?
Yeah. If you can take that.
Yeah. A big part of that is the capitalization. It's also a bit of restructuring and some purchase price adjustments, et cetera. I would put it like this, what is not any cash flow impact is the book, the net value of the assets.
Okay.
Yeah.
We also have one question having been put through the web, and it regards our view on M&A and whether we see any potential for any new term deals.
Exciting with the new structure that we have, we have these 27 entities, and they all are in different places in the development. As I mentioned during the Capital Markets Day, that the operations that are both stable and profitable, they should be focusing on growth. We have quite a lot of these entities in Sandvik, as you probably understand. They need to focus on growing the business. You can do it organically as well as through margin acquisitions. We encourage them to go this direction. You need to be stable and profitable before you go for acquisition. That's important. It will definitely be one important part of the growth for Sandvik in the future.
Coming back to the financial charges that we talked about here just half an hour ago, or a little bit half an hour ago, this is why it's so important for us to improve the gearing in the company from today's 1.0 to 0.8 because we have to create some space in the balance sheet, so that we can be a bit more active on M&A, for the future. There's not much space today for major acquisitions in the balance sheet.
Right. We'll go back to the conference call, please. Operator, can you put through the next question?
I can. The next question comes from Lars Brorson of Barclays. Go ahead, sir. You're live.
Hi, it's Lars from Barclays. Hi, Björn, Tomas, Ann-Sofie. Just a quick one follow-up on Mining Systems, because I couldn't hear what Tomas said. Can I just be clear, are you injecting any cash as part of your sale of the Systems business? If so, how much? Just to be clear, are there any other contingent liabilities, any performance-related conditions to the sale, earn-outs, et cetera?
On the cash side, yes, we do capitalize the company. We haven't disclosed and we're not disclosing the parts of the deal as such, but the capitalization is the biggest one.
As you probably know also that the company has been making losses during the last time. There are some restructuring measures that are being taken to make sure that the company is not losing money.
Thanks. If I can just return to SMS, thanks for the update on Brexit. U.K. is 5% of group. How much is it for Sandvik Machining Solutions? Just on your European trading, Björn, in Sandvik Machining Solutions, you said earlier, I think on the press call that Q3 hadn't really been much worse nor much better than Q2. Perhaps you can give us a sense for where the monthly trading trends have been in Europe through the course of Q2 and what you've seen, if anything, in the U.K. in the three, four-week post Brexit.
During this quarter, it's actually only 14 days since the quarter started, I think it's a little bit early. We haven't seen any changes in the development than we have seen at the previous quarter.
How big is U.K. in SMS?
For SMS?
SEK 1.4 billion.
Yes. SMS is SEK 1.4 billion.
Thanks.
Pretty similar to the group.
Yeah. The percentage.
In percentage, yes.
Thank you very much. We'll continue with the next question from the conference call, please.
Thank you. Our next question is from James Moore of Redburn. Your line is open, sir. Please go ahead.
Thanks. Hi, everyone. Björn, Tomas, Ann-Sofie. I'd quite like to touch on three topics if I could. Just on SMS and Europe. You've gone up from zero to 4% organic order growth. That's quite a big plus. I just wondered if you could perhaps help us a little bit more understand the growth trends north, south. I know you have quite a big Eastern European and Russian business, and it collapsed a year and a bit ago with the ruble, so I'm imagining maybe Russia's helping that, but could you maybe give us some color on the change in growth there?
I don't have those numbers at the moment. Maybe Ann-Sofie, do you have those numbers?
Yes. I think in general for Europe, we can say that the eastern part of Europe has certainly contributed to a big extent to the total for Europe, and Russia not least. Albeit, they're clearly, like you allude to, coming from very low levels. Yes, the eastern parts have certainly been outgrowing the western parts through the quarter.
Western is still positive?
Closer to flat than positive, yes.
It is really all the Eastern Bloc? Okay.
Yes. They've done well through the quarter.
Just within SMS, you talked a bit at the Capital Markets about round tools outgrowing inserts. Maybe that's difficult on a quarterly basis, but is that
Actual trend continuing at the moment in the quarter, can you see the difference, size the difference?
Is that for the quarter or a broad question?
Really for the quarter, whether that trend continues, that round tools are still outgrowing inserts.
Yes. Aerospace is one of the segments that is doing the strongest. That's a big and important segment for round tools. I think it's fair to say that the pattern is fairly similar still.
Great. Just turning to SMT, if I could, you talked about deferrals back at the Capital Markets Day and orders moving to the right. I just want to be clear, has that trend continued or have you actually seen some umbilical business come in that surprised you?
There are some interesting possible orders, I would say it's always too early to say anything before you close them. There are some, as I mentioned there, I'm a little bit optimistic that there could be.
Okay. Just finally, I'd just like to understand, if I could, on Mining Systems. It looks like you're effectively paying the buyer to offload the business, half a billion plus SEK, given some are optimistic about being at the bottom of the cycle, me less so, I just wonder why is it that people don't see better option value than that if you're going to capitalize it and restructure it?
Yeah. We don't go into all the details, the buyer is, of course, putting in capital also in this business. We need to put it at a stage where it can stand on its own legs and that it has a possibility to survive. We need to do this. During a period, as you have seen, it's been a struggling business for us, and we need to put it in shape, and that's why we need to inject the capital.
Great.
Without going into any details, James, we have, of course, looked at various options. Also from a financial point of view, this is the best option.
Awesome. Thank you very much.
Thank you, James. Operator, can we have the next question, please?
Indeed. The next question comes from Philippe Vaquerin of Exane. Philippe Vaquerin, your line is open.
Hi. Good afternoon. Maybe just to clear the question on Mining Systems. You have the capitalization, you don't mention the agreed price. I understand if the agreed price exceeds the capitalization or not? That's the first question.
As we've said, we don't go into all the details, where the capital injection has been or what is the purchase price and so on. We will not disclose that.
Okay.
We disclose that the capital effect is SEK 600, and the capital loss is about SEK 800 in this sale.
Okay. Just also a bit on the underperforming business units. How have they performed over the last three, six months profitability-wise? Are they a larger drag on group operating profit than they were in 2015?
You're still talking about Mining Systems or?
No, no, the overall underperforming business units you highlighted during the Capital Markets Day.
No, I didn't get the question.
He's talking about the bubble chart.
The ones on the left-hand side?
Yep.
Below the zero line. Okay.
It's the famous bubbles. One of the big bubbles in the left corner was the Mining Systems. That is correct, which is being taken out. We have, of course, other bubbles which is underperforming, where we are putting a lot of efforts now with owning their own costs and their own balance sheet is to make sure that they are moving up to the profit area. What we say, and I come back to that, we do not expect any quantum leap changes. It's all this continuous improvement, which is important. We focus on the businesses where there is a market attractiveness and where we believe that Sandvik will contribute to these businesses, that they are part of these three businesses that we are focusing on.
Final question on the elimination line at SEK 220 million in the quarter. It includes a quite large negative effect, and we ask i f we exclude it's closer to SEK 170 million in the quarter. Have you started to put back some central cost into divisional areas, are we now at SEK 150 million-SEK 200 million level a quarter? Is it a new normal level?
I think you're referring to the central costs that were lower during the quarter. I think we are putting in a lot of saving efforts on the central part. If you remember what we talked about during the Capital Market Day, that we had a certain amount of the costs, which is a pretty big one, where we also first transferred it over to the different businesses. We have started to moving some of these costs back to the operations, and that will continue during the whole year. That's taking place. When you look at the lower cost for the central part, that is a clear cost savings on the central costs for central functions.
Okay. That means that the divisional areas performance is even better than what you show when you compare with Q2 2015.
In the saving there is a saving also that meant that there is a little bit less distributed costs also over to the businesses.
Yeah. We have a model where the central costs are allocated to the businesses. When we're moving them, it doesn't mean that the businesses are taking on more costs. They get the resources and the people and the systems and what have you.
Then it's up to them, of course.
Yeah
To decide what resources that they need and do not need.
Yeah.
That varies, of course, between all the different businesses.
Yeah. When we look at the business areas and the product areas, it is apples for apples. What we're doing here is that we're giving them the power to directly influence the cost.
Okay. Thank you.
As opposed to distributing a big chunk of corporate common costs.
Okay. Very clear. Thank you.
Thank you very much. I believe we have a few more questions from the conference call, please. Can you please put through the next one?
Indeed. The next question is from Daniel Schmidt of SEB. Go ahead, sir, your line is open.
Yes, hello, this is Daniel Schmidt from SEB. Good afternoon, everyone. I just wanted to ask you on SMS and the EBIT margin there again, which really takes a step up in the second quarter. If you look at this adjusted for seasonality, how linear should we model this EBIT margin progression? Is this the floor now going forward, or is there any specifics in the Q2 numbers that we need to consider looking into the coming quarters and years?
No. I think number one is we will not start guiding forward to the different operations. I would say it is a clean report, so there's nothing extra which has been added on to the SMS business. Where we end up forward, that we will see. They will continue to focus on keeping the costs under control. They still haven't completed the supply chain optimization program. That will continue. We have a flat development in the volume, so we haven't much help from that during the period, and we had the headwind in the currency. It's of course important to see if we can get some growth in the future. That will, of course, also depend on the development going forward, but that's too early to say.
I think part of your question was a little bit about straight line and seasonality, and of course, there is a strong seasonality in the SMS business because it's immediately dependent on the manufacturing activity worldwide. When Western Europe closes in August, for example, of course, it's not much sales. You can take 21.8% as a floor and apply for Q3 and Q4 seasonality still there.
Yeah. Absolutely. No, I understand that. All right. Would you say that this is in line with your expectations that you presented at the CMD to make this sort of journey to come to the 16% for the group? Okay, this is still early in that journey, but the SMS performance, is that in line with what you expected?
I think SMS probably over-delivered slightly, and maybe some of the other businesses under-delivered slightly compared to the expectation. I think overall it's pretty much in line with our expectations.
Thank you, Björn and Tomas.
Thank you, Daniel. Can we have the next question, please, from the conference call?
Indeed. The next question is from Graham Phillips of Jefferies. Go ahead, sir. Your line is open.
Yes, good afternoon. My question is again on SMS margin. Can you talk a little bit about the geographic mix? When you look back in the last quarters, there's been negative contribution to the organic profit bridge coming through in this division. We've obviously had a positive in the second quarter with slight organic growth. There's obviously a mix thing going on, and with Europe being stronger, North America down, are margins substantially higher in Europe than North America?
The first point I would like to say, if you look at gross margin, it's pretty steady, I would say. Maybe a slight up on that part. I think it's very much related to savings that this is taking place.
Okay. The savings, again, are they geographically focused? Are they going to continue to I know you commented on the seasonality, but within the product areas, again, we just see the EBIT margin on the bridge for the divisions. Is aerospace and defense and automotive higher margin at an EBIT level?
I think if you look at automotive, it's always been seen as the segment where you had a lot of challenges when it comes to margins. Not really.
Okay. Just moving forward on the new divisional structure, when do you anticipate that we'll have a pro forma going backwards, and how long will you provide a pro forma going back, and what sort of level of detail will we get in terms of organic growth and profitability and so on?
Yeah. It's going to take some time. It's going to take a little bit more than two months to redo the numbers. We have the ambition to go out with the press release in September with the historical data on the new structure going back three years.
Three years. Will that be quarterly or?
Yes, it will be quarterly so that you can do all your comparisons and trend charts and whatever.
Okay. Thanks very much.
Thank you. Do we have time for one more question from the conference call? If it's a quick one, please.
Okay. The final question from the conference call is from Max Yates with Credit Suisse. Go ahead, sir. Your line is open.
Hi. Thank you. Just a quick one on the construction business. I just wanted to understand a bit more about the margin there, and specifically, what part of that business had got worse year-over-year to result in the 2.3% margin in Q2.
Firstly, I think you have to see that the volumes are down. If you see year-over-year, I think that's probably automatically, you get some under-absorptions in the production facilities. As I mentioned, is that if you really want to compare it with previous quarter, you should be adding back about SEK 40 million in cost, that provision that we have taken during Q2. If you add that on, you end up between 3.8% and 4.0%. That's about where the level is of the construction business at the moment.
Okay. Should we see any reason as we move into the second half that from that level, it should deteriorate? Is there anything across the regions that concerns you?
The new structure is, of course, significantly different from the. Now the same production units, they do not split their cost between mining and construction. If you are, for instance, in surface drilling, it doesn't matter if you go into the mining or construction, you have to make sure that this cost is what you need to put in relation to your revenues. The management teams will be running their operations. You will have eight management teams driving that efficiency for the different products. It means if you have under-absorptions or you don't have enough capacity in the factories, you have to adopt that. That would be very strong focus from each of them.
Sure.
I think it's a little bit early to say on the construction side. I mentioned that before that I think we were organically down 13%, which is quite a big number, I think. If you lift out that order, it's about 6%. If you look where the focus is at the moment, where the best activities is actually in the Nordic region here, that Norway and Sweden is a really big construction related to infrastructure and tunnel. I think we've been putting in a lot of efforts during the last quarter, both in Finland, in Sweden, and in Norway, to make sure that we get a good stake out of that exciting business that is coming. We will continue to do that focus.
Sure. I know you said mobile crushers at the Capital Markets Day was obviously a focus on turning that business around. Have you started to see any positive effects from work?
The quarter was a pretty tough time for the mobile crushers when it comes to the volumes. That's pretty clear.
Okay. Thank you very much.
Very much. I know we've run out of time. I know there are still questions out there, both on the conference call and on the web. Please feel free to contact us at Investor Relations and we'll be more than happy to help you. With that said, thank you very much for joining us here today, and we bid you all a very good summer.
Thank you.
Thank you.